The archived blog of the Project On Government Oversight (POGO).

Apr 08, 2010

Who Discovers More Corporate Fraud: Whistleblowers, Regulators, or Journalists?

A new study
in the Journal
of Finance offers a friendly reminder
of the key role whistleblowers play in rooting out fraud, waste and
abuse, finding that corporate fraud is more likely to be
detected by an
employee from within a firm, rather than external auditors, government
regulators,
self-regulatory organizations, or the media.

The study examined a
total of 216 cases of alleged corporate fraud. Employees, i.e.
whistleblowers, were responsible for revealing the fraud in 17 percent
of cases — more than any other type of
source — in which the fraud was not
first brought to light by a firm's management.

For
its part, the
Securities and Exchange Commission (SEC) revealed the wrongdoing in
only 6.6 percent of such cases.

A
natural implication
of our findings is that the role of monetary incentives should be
expanded. We find that the use of monetary rewards provides positive
incentives for whistleblowing.

As Michael mentioned earlier
this week, Congress is now considering legislation to improve the SEC's
program to reward whistleblowers, which in over 20 years of existence has
resulted in payments to only five people. Hopefully this
report can serve as another coal in the fire to cook up a better system.

Despite the crucial role that whistleblowers often play in uncovering corporate wrongdoing, they rarely receive help when they face retaliation from their employers. A study conducted a few years ago found that only 3.6 percent of Sarbanes-Oxley whistleblowers win relief through the initial administrative process, and that only 6.5 percent win on appeals. The study also found that administrative judges have often strictly construed or even misapplied the SOX provisions on whistleblower protections: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=977802

In addition to improving the SEC's whistleblower reward program, Congress should also incorporate provisions from Sen. Dodd's financial regulatory reform bill that would strengthen protections for whistleblowers who assist the SEC with any of its investigations or administrative/judicial actions.